Yellen Opens Door to Reforms of Enhanced Leverage Ratio

Testifying before the Senate Banking Committee today, Federal Reserve Chairman Janet Yellen acknowledged that aspects of the agency’s enhanced supplementary leverage ratio “may be having unintended adverse consequences” and said the Fed is looking into changes. Specifically, Yellen addressed concerns expressed by senators from both parties that the enhanced SLR is negatively affecting custody banks that serve institutional investors.

For example, by including riskless assets such as reserves held at the Fed in its denominator, the enhanced SLR can increase volatility and raise costs that are passed on to customers. In the case of custody banks, Sen. Mike Rounds (R-S.D.) noted, this means that the structure of the enhanced SLR reduces returns for American retirement savers as mutual funds absorb higher costs to banks.

“Perhaps it’s too high relative to risk-based capital requirements,” Yellen said of the enhanced SLR. “It is something where a regulation perhaps has had an unintended consequence, and we are looking at that carefully,” she added, although she did not specify a timeframe for a change. Among the possible options she identified were exempting central bank reserves from the denominator and recalibrating the leverage ratio.

The American Bankers Association has long pointed out the downsides of the current enhanced SLR calculation, most recently in its white paper sent to the Treasury Department this spring. “The inclusion of riskless assets (such as cash and bank reserves place with the Federal Reserve) in the denominator of leverage ratios could feed systemic risk,” the association said. “This would be especially likely during times of financial market stress when banks receive significant inflows of deposits.” For more information, contact ABA’s Hugh Carney.

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